November 15, 2017 Partnership considerations of Senate Finance Committee Chairman's Mark On November 9, 2017, the Senate Finance Committee released the Chairman's Mark of the Tax Cuts and Jobs Acts (the SFC Chairman's Mark). The SFC Chairman's Mark describes changes to provisions affecting partnerships that, if enacted, will: (1) codify Revenue Ruling 91-32; (2) expand when mandatory basis adjustments apply on the transfer of a partnership interest; and (3) provide that charitable contributions and foreign taxes paid are subject to the Section 704(d) limitations. The SFC Chairman's Mark and the Ways & Means Committee bill passed by the committee on November 9, 2017 differ in significant ways in their application to partnerships. See Tax Alert 2017-1847 for an overview of the Ways & Means Committee bill. Process summary and background The staff of the Senate Finance Committee released a section-by-section explanation of the SFC Chairman's Mark on November 12, 2017 and markup by the full Senate Finance Committee began on November 13, 2017. The Tax Cuts and Jobs Act, originally released on November 2, 2017, by Ways & Means Committee Chairman Brady, was amended on November 3, 6, and 9 (the original bill jointly with its amendments, the W&M Bill). The House Ways and Means Committee approved the W&M Bill on November 9, 2017. The W&M Bill is under consideration by the full House of Representatives. Sales of partnership interests by foreign partners In Grecian Magnesite,1the Tax Court declined to follow Revenue Ruling 91-32,2 holding that the gain recognized by a foreign person on its redemption from a partnership engaged in a US trade or business did not result in effectively connected income (ECI). The SFC Chairman's Mark would effectively reverse this decision, codifying a result similar to that of Revenue Ruling 91-32, such that gain or loss from the sale or exchange of a partnership interest by a foreign partner would be ECI that is taxable in the US if the gain or loss from the sale or exchange of the underlying assets held by the partnership would be treated as ECI. In addition, the SFC Chairman's Mark would require that a purchaser of a partnership interest withhold 10% of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or a foreign corporation (similar to the operation of the FIRPTA rules applicable to sales of US real estate by foreign owners). The proposal would be effective for sales and exchanges occurring after December 31, 2017. According to the JCT, the provision would increase revenues by $3.8 billion from 2018 through 2027. Comparison to W&M Bill The W&M Bill does not address the treatment of gain or loss from the sale or exchange of a partnership interest by a foreign partner. Mandatory basis adjustments for transfers of partnership interests with built-in losses The SFC Chairman's Mark would require a partnership to adjust the basis of its assets upon the transfer of a partnership interest, if the partnership has a built-in loss of more than $250,000 in its assets (as under current law), or if the transferee of a partnership interest would be allocated a loss of more than $250,000 upon a hypothetical taxable disposition by the partnership of all of the partnership's assets for cash at fair market value, immediately after the transfer of the partnership interest. This provision would expand the application of mandatory downward basis adjustments on transfers of partnership interests by taking into account gain and loss allocations to the transferee. The proposal would be effective for transfers of partnership interests occurring after December 31, 2017. According to the JCT, the provision would increase revenues by $0.5 billion from 2018 through 2027. Comparison to W&M Bill The W&M Bill does not address mandatory basis adjustments under Section 743(d). Partner loss limitation to include charitable contributions and foreign taxes Under existing law, Treasury regulations do not take into account a partner's share of partnership charitable contributions and foreign taxes paid or accrued in applying the Section 704(d) basis limitation on partner losses. The SFC Chairman's Mark would modify the basis limitation on partner losses provided under Section 704(d) to include as losses, the partner's share of partnership charitable contributions and foreign taxes. This would conform the basis limitation that applies to partnerships to the treatment of these items by shareholders in an S corporation. The proposal would be effective for partnership tax years beginning after December 31, 2017. According to the JCT, the provision would increase revenues by $1.2 billion from 2018 through 2027. Comparison to W&M Bill The W&M Bill does not address the treatment of a partnership's charitable contributions and foreign taxes paid under the partner's basis limitation rules. Carried interest The SFC Chairman's Mark does not contain provisions targeting the treatment of partnership profits interests issued in exchange for the provision of services to the partnership (so-called carried interests). Nonetheless, it appears that Senator Grassley proposes to amend the SFC Chairman's Mark to include such provisions. Comparison to W&M Bill Under an amendment to the W&M Bill adopted on November 6, capital gains allocated in accordance with carried interests held in connection with the performance of services would be eligible for long-term capital gain treatment (i.e., 20% tax rate) only if the underlying capital asset (e.g., stock, debt security, investment real estate, partnership interest, etc.) is held for at least three years. If the three-year holding period is not satisfied, any gain allocated to the carried-interest holder would be treated as short-term capital gain, taxable at a partner's marginal income tax rate (e.g., as high as 39.6% federal). The amendment would not otherwise change the nature or character of the income. Technical termination The SFC Chairman's Mark does not contain changes to the rules related to a "technical termination" of a partnership under Section 708(b)(1)(B). Comparison to W&M Bill The W&M Bill would repeal Section 708(b)(1)(B) for partnership tax years beginning after December 31, 2017. Self-employment income The SFC Chairman's Mark does not contain changes to the net earnings from self-employment rules for partners or shareholders of an S corporation. The W&M Bill, as passed, also does not contain such changes. Comparison to W&M Bill A second amendment to Chairman Brady's proposal removed certain proposed changes to the definition of net earnings from self-employment. The removed proposals (discussed in Tax Alert 2017-1847) would have eliminated the limited partner exception of Section 1402(a)(13) and would have treated an S corporation shareholder's distributive share of income attributable to "labor" as "net earnings from self-employment," after taking into account wages paid to the shareholder. Summary chart comparing SFC Chairman's Mark to W&M Bill
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——————————————— 1 Grecian Magnesite Mining, Industrial & Shipping Co., SA vs. Comm'r, 149 T.C. No. 3 (Jul. 13, 2017). 2 1991-1 C.B. 107. | |||||||||||||||||||||||||||||||||
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